Tuesday, February 12, 2013

The big idea behind the UK Vickers Commission’s “ring fence” is to separate two allegedly distinct parts of the banking industry. One is the risky / investment banking part (p.10). The second half consists of essential / “retail” / day to day forms of banking activity without which the economy would grind to a halt: running ATMs, organising credit cards, honouring cheques drawn by small businesses and households, etc. This part is allegedly relatively safe.

Regulators the world over seem to have accepted the idea, plus the separation idea is a big part Glass–Steagall.

The basic flaw in that idea is that there is no very clear distinction between the two halves. Here are three illustrations of that lack of clear distinction.

1. Lehmans type investment banks.

The idea that investment banks are not essential for the day to day functioning of the an economy is very debatable. Lehmans was an investment bank: it did not do any retail banking. But it is widely agreed that the effect of the Lehmans failure was near catastrophic. Indeed, the Vickers commission could not bring itself to say in plain English whether they’d let Lehmans type banks actually fail, according to Laurence Kotlikoff (p.10).

Moreover, it looks like markets have sussed the fact that those too big to fail banks (investment or retail) just won’t be allowed to fail. And apart from LARGE investment banks, there are the hundreds of shadow banks the flight from which had much to do with the crunch.

2. How much “retail banking” is essential?

As to the idea that the large majority of retail banking is essential for the economy to function, that is equally debatable. For example much of the money that funded property speculation prior to the crunch would have been classified as retail had a Vickers type fence been in operation at the time. That is, a significant portion of those loans were granted to ordinary households to enable them to buy more or larger properties than they ought to have done. Plus a significant proportion of those loans went to small property developers (and Vickers puts small firms on the “safe / retail” side of the fence).

3. Large domestic corporations.

And then there are ordinary banking services for LARGE domestic firms or corporations. Here, Vickers is not clear on which side of the fence this activity should be (p.11). Now if Vickers is not clear on which side of the fence this very significant portion of all banking activity should lie, that calls into question the distinction that Vickers is trying to make, doesn’t it?

Provisional conclusion: Vicker’s ring fence is a bit like placing a “fence” between England and Scotland on a line running North/South down the centre of the UK: the people on one side of the fence would not be any more Scottish (or English) than those on the other side.

But the fact that the ring fence does not make much sense is not to say Vickers’s basic objectives don’t make sense.

Vickers’s objectives.

Vickers’s basic objectives are

1.to minimise taxpayer funded bank subsidies

2.to discard the current bias in favour of large banks (that’s the too big to fail subsidy (TBTF)), i.e. improve competition.

3. Minimise the chance of bank failure, particularly failure of parts of the banking industry without which the economy would cease to function.

Now in contrast to the thousands of pages that Basel III and Frank-Dodd consists of (lawyers’ paradise), there is a beautifully simple set of rules that would put Vickers’s objectives into effect, and as follows.

Rule No. 1. A 100% safe bank account is a basic human right, and the state will underwrite any such account as long as no risk whatever is taken with the relevant money. That way there is next to no taxpayer exposure and no bank subsidy.

Rule No. 2. Those who want their money loaned on or invested are treated in exactly the same way as if they invest direct in the stock exchange or make any other investment: they’re on their own. If the relevant loans or investments fail, then those who wanted their money put into such loans or investments bear the cost. That way, again, there is no taxpayer exposure or bank subsidy. Moreover, it’s virtually impossible for banks as such to fail.

The banker lie that every politician falls for.

And finally, the entirely predictable objection from the banking industry that the latter policy will hinder lending and have a deflationary effect or “hinder growth” is total and complete nonsense: any deflationary effect can easily be countered by conventional fiscal or monetary stimulation. And that costs nothing in real terms.

As to the other predictable excuse proffered by banks, namely that they should be allowed to gamble at the taxpayers’ expense, the banking industry needs to tell us why other forms of investment (stock exchange, business angels, etc) should’nt also get billion dollar taxpayer funded subsidies and be allowed to gamble at the taxpayers’ expense.

Of course the banking industry would be totally unable to answer the latter question. Unfortunately that probably won’t stop politicians taking bribes from bankers and implementing the legislation that bankers want.